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The Failure of Stakeholder Capitalism

It is a recipe for cultural conflicts, political backlash, management paralysis, and nightmares about human resources. It’s also anything from pleasant.

Wouldn’t it be lovely if businesses cared more about the common good and less about profits? It’s common to believe this. Stakeholder capitalism is now popular. It is not shareholder capitalism.

Today, a large number of high profile academics and business figures reject the opinion Milton Friedman stated in a well-known piece for the New York Times Magazine in 1970:

A corporate executive is an employe of the owners of the business. He has direct responsibility to his employers. That responsibility is to conduct the business in accordance with their desires, which generally will be to make as much money as possible while conforming to the basic rules of the society, both those embodied in law and those embodied in ethical custom.

Some people appear to believe that we would live in a progressive utopia of high wages, racial harmony, economic equality, and environmental purity if only this evil idea of increasing profits hadn’t been invented.

The Business Roundtable rejected the Friedman doctrine in 2019 and embraced the idea of running businesses for the “benefit of all stakeholders — customers, employees, suppliers, communities, and shareholders” in its new “Principles of Corporate Governance.” How firms would settle disputes between constituents was not specified.
Conflicts are fictitious, is the typical reaction. You’ll succeed if you do good.

In today’s globally interconnected world, a company must create value for and be valued by its full range of stakeholders in order to deliver long-term value for its shareholders, wrote BlackRock’s Larry Fink in his 2022 letter to CEOs, reiterating the message that made news in 2018: To prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society.

Of course, stakeholder and shareholder capitalism would be the same if initiatives aimed at appeasing stakeholders and the generation of economic value always went hand in hand. However, life is not that easy.

Contrary to what you may have heard, prioritizing stakeholders over business goals is not a nice thing to do. Managers are not just tempted by stakeholder capitalism to advance their personal agendas. It is a recipe for cultural conflicts, political backlash, management paralysis, and human resources nightmares.

Every successful business must take into account the interests of its stakeholders, including consumers, suppliers, and staff. However, not everyone has the same priorities, and organizations may need to compromise between objectives that they may all deem to be worthy. What to do in a conflict situation is the question.

Without a focus on value maximization, managers have too much freedom to spend corporate funds on their own interests.

The great value of the Friedman doctrine is that it gives a consistent standard for making tradeoffs. According to Harvard Business School economist Michael Jensen in a 2010 paper, maximizing economic value instructs you to “spend an additional dollar on any constituency provided the long-term value added to the firm from such expenditure is a dollar or more.”

In contrast, the stakeholder theory provides little information. It presumes that you just satisfy everyone. In addition, Jensen noted:

Without the clarity of mission provided by a single-valued objective function, companies embracing stakeholder theory will experience managerial confusion, conflict, inefficiency, and perhaps even competitive failure.

The greatest explanation of why what Ensen refers to as “enlightened value maximization” is essential can be found in his paper.

He and Friedman, however, did not completely comprehend the chaos that might result in their absence.

Take a look at the outrage after Walt Disney Company attempted to placate dissatisfied workers by opposing a Florida law that would have prohibited addressing sexual orientation with younger students in schools. A sense of betrayal by a beloved company, whose fans find their ambitions and beliefs reflected in its characters and storylines, was echoed in the political response, much like in the initial protests.

Others were turned off by appeasing one group of stakeholders. Conservatives had no difficulties finding opponents within the company. Disney has nearly 200,000 employees and countless customers. All are stakeholders, and they represent every conceivable viewpoint.

Contrarily, Netflix has more successfully handled its own problems by focusing on financial objectives, despite other difficulties, from conservative backlash over the French film “Cuties” to more current demonstrations over Dave Chappelle’s jokes about trans women. The organization updated its cultural norms for employees to explicitly state:

As employees we support the principle that Netflix offers a diversity of stories, even if we find some titles counter to our own personal values

Stakeholder capitalism indirectly assumes that the cultural consensus is the same as whatever its proponents may think to be true. It harkens back to the middle of the 20th century, when large US corporations enjoyed little competition, the media mostly ignored all but a small subset of political, religious, and social viewpoints, and worker expectations were primarily based on hierarchy and security. It denies the existence of social media, Slack channels, and “bringing your whole self to work.”

Forget profits and political disagreements to experience stakeholder-oriented management in its purest form. Take a look at the turmoil affecting many left-leaning NGOs. Ryan Grim details why Washington D.C.-based groups have spent the past few years engaged in “knock-down, drag-out fights between competing factions of their organizations, most often breaking down along staff-versus-management lines.

He writes that:

Instead of fueling a groundswell of public support to reinvigorate the [Democratic] party’s ambitious agenda, most of the foundation-backed organizations that make up the backbone of the party’s ideological infrastructure were still spending their time locked in virtual retreats, Slack wars, and healing sessions, grappling with tensions over hierarchy, patriarchy, race, gender, and power….

Grim quotes the executive director of one such group, anonymously:

A lot of staff that work for me, they expect the organization to be all the things: a movement, OK, get out the vote, OK, healing, OK, take care of you when you’re sick, OK. It’s all the things, said one executive director. Can you get your love and healing at home, please? But I can’t say that, they would crucify me

The head of one organization, who also spoke anonymously, told Grim that “you couldn’t conceive of a better right-wing plot to paralyze progressive leaders.,” despite their shared desire to improving the world and general agreement on what it means.

Not being a leftist is not the issue. Their objectives and choices are frequently contested internally. Their managerial structures have lost all credibility due to new mindsets and communication methods.

Businesses that prioritize generating economic value have the advantage of having a clear definition of success compared to organizations with a mission. They should make an effort to maintain that standard if they want to improve the world.

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